Opinion: Is consumer debt the bubble that finally ends the economy’s strong run?

Tim Mullaney says investors who fear negative impacts of record consumer debt or rising wage growth have it all wrong

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By

TimMullaney

Writer

When the economy is in the late stages of an expansion, like it is now, everyone begins hunting for the bubble that will pop and end the fun.

Lately, that has taken two forms: Workers Are Getting Raises That Are Too Big (a new one that emerged only with Friday’s jobs report) and People Have Taken On Too Much Debt. “Consumer debt reaches record high — haven’t we learned?” read a blaring-but-representative headline trumpeting the fact that an American economy that has reached record size has also amassed a record amount of consumer debt.

It’s popular to watch consumer behavior to look for bubbles. After all, retail investors pile into stocks late in cycles, and the last big recession came after they went bonkers borrowing money to buy and renovate houses.

But I’m here to call this out. There still is no bubble — not in wages, not in consumer debt, and certainly not in inflation. Expectations are rising for ever more interest-rate hikes; the futures markets think the Federal Reserve will boost rates at least three more times this year, with a chance of as many as five hikes. But the central bank, the Dow Jones Industrial Average
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the Treasury market
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and pundits are all chasing phantoms.

Let’s start with why there’s no debt bubble — but the Fed could, in theory, create one while intending to do the opposite.

We Americans owe a grand total of $3.8 trillion in consumer debt, including $1 trillion in revolving debt, according to the Fed. At the same time, consumer spending picked up in the fourth quarter, rising at a 3.8% annual rate, according to the Commerce Department. But the full-year figures showed growth in the biggest part of the economy no faster than in 2016 and significantly slower than in 2015.

The reason consumer debt is so manageable is precisely that interest rates are so low — and the only thing the Fed can do by raising interest rates, really, is make things worse. Even with debt higher than it has ever been, the monthly cost of servicing that debt is near the lowest level in 35 years, meaning consumers can do it easily, according to Moody’s Analytics.

“We are still a significant way from a problem in household credit,” Moody’s chief economist Mark Zandi says. “Subprime auto and retail card lenders had been aggressive in extending credit, but both have responded to an erosion in credit quality over the past year by tightening down on standards, and loan growth is slowing sharply.”

This logic changes as rates rise — albeit slowly. Zandi thinks there’s little chance the Fed could raise rates fast enough, in fact, to really get consumers in trouble. One reason is that Americans spent the years after the financial crisis refinancing themselves; now their debt is cheap, long-term and fixed-rate. Before 2008, more than a third of mortgage originations were adjustable-rate, often because loans went to people who needed the low initial rate to get the mortgage. After 2008, that number fell as low as 4% (it’s now about 13%).

About a quarter of household debt has an interest rate that can adjust within a year of a Fed-induced change in market interest rates, Zandi said. In the late 1980s, this number was more than one-third. Part of that is rising preference for fixed-rate mortgages, and part is that consumers have rolled high-rate, adjustable credit-card balances into mortgage refinancings.

The question is, how much can that basic picture of solvency change? And, why we would change it on purpose?

The Fed would change it by raising rates because it has convinced itself that inflation is coming, and will sustain itself, finally, around the central bank’s 2% target for the first time since the early 1990s. But little in recent inflation data points to acceleration. As Jeffry Bartash reported for MarketWatch, core consumer-price inflation for the last 12 months ticked up to 1.8% from 1.7% last month, but, he added, “it’s been stuck in that range for eight months in a row.’’

Plus, in case you’re all worked up about Wal-Mart raising pay for store associates, JPMorgan Chase instituting a minimum wage for tellers or Boeing and AT&T handing out bonuses, real wage increases are no larger than they were in 2014 or 2015 even with the uptick in pre-inflation pay noted in Friday’s jobs report. Until then — and we still don’t know if January’s jobs report was a fluke — real wage gains have actually been smaller.

Translation: There is no inflation, certainly not driven by wages. (What inflation we’ve seen in recent months has been about gasoline, housing prices, and to some degree medical services). All there have been is scattered data points suggesting that inflation is less dormant than it once was. Slightly.

And since central banking is a game of balancing risks and rewards, there’s a lot of room for concern that the Fed is weighting the risk of inflation too much, and planning to raise rates too fast.

After all, the run of companies announcing relatively-small pay gains since President Donald Trump passed his corporate tax cut isn’t really new, as the slowdown in real wage growth suggests. The Gap raised pay in 2014, as did Wal-Mart in 2015, boosting its minimum pay to $9 an hour, with $10 after a probationary period. Wall Street hated the idea, and it took the retailer two years to recover from a stock drought that occurred about the same time.

It would take a lot of rate hikes to dent the basic creditworthiness and solvency of households.

So why is the market looking for so many rate increases this year?

The reason is an assumption that a tightening labor market will boost wages more — and that higher wages will translate pretty directly into inflation.

But we’ve all been wrong about this for long enough to give some pause. I speak as the author of a piece declaring 2014 “the year of the raise,” which eventually proved about half-true but took an uncomfortably long time to do even that. And any inflation pickup that’s plausible — it won’t be much, soon anyway — isn’t worth taking chances to head off. If Trump were right about the corporate tax cut spurring investment, in fact, productivity gains would head off inflation pressure.

The question is whether the enemy of this expansion will prove to be ourselves. Zandi is correct that it would take a lot of rate hikes to dent the basic creditworthiness and solvency of households. But if the risk is taken at all, it should happen in the service of a worthier cause. Nothing in the inflation case is new.

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